Tuesday, January 12, 2010

Observations about mergers and acquisitions.

Post 405 - Most mergers and acquisitions do little to increase the acquiring company’s bottom line. A KPMG study of 700 mergers found that only 17% created real value, and that more than half destroyed it. And a McKinsey study of mergers that took place in the nineteen-nineties found that less than a quarter generated a positive return on investment.

The myth of synergy seems to appeal to many executives’ sense of themselves as magicians. As Warren Buffett has observed, executives see the companies they acquire as handsome princes imprisoned in frogs’ bodies, awaiting only the “managerial kiss” to set them free. Unfortunately, most frogs turn out to be as ugly as they look, and magic kisses are harder to bestow than executives believe. Only a few companies today - Cisco is one - have consistently been able to acquire firms and then improve their performance and profitability.

Merger mania also rests on the fallacy of ownership - the assumption that you have to own a company to make money from it. However, much of the benefits that mergers are supposed to accomplish can be achieved instead through partnerships and alliances. Google has made deals to handle searches and advertising for companies like A.O.L. and I.A.C., giving it access to their customers without the hassle of acquiring them. And I.B.M. has marketed the products of its competitors, Sun Microsystems and Novell, aallowing it to expand its offerings and its potential customer base.

According to a recent analysis of a number of merger studies, mergers that rely more on cost-cutting - combining back-office operations, eliminating redundancies - than on promises of fast growth are more likely to be successful. Acquisitions of smaller, newer private companies are usually a better idea than acquiring publicly traded companies as they’re more likely to provide access to new technologies or products, and more likely to be acquired at a good price. In 2000, for instance, Microsoft paid less than $40M to buy the video-game developer Bungie, the creator of Halo. In the six years that Microsoft owned the company, Bungie’s products brought it well over a billion dollars in revenue.

So, history suggests that, when it comes to mergers, the best response is often to do as Nancy Regan advised and "just say no." A decade ago, America Online merged with Time Warner in a deal valued at a stunning $350 billion. It was then, and is now, the largest merger in American business history. The trail of despair in subsequent years included countless job losses, the decimation of retirement accounts, investigations by the Securities and Exchange Commission and the Justice Department, and countless executive upheavals. Today, the combined values of the companies, which have recently been separated, is about one-seventh of their worth on the day of the merger. To call the transaction the worst in history, as it’s now taught in business schools, doesn’t even begin to tell the story of how some of the brightest minds in technology and media collaborated to produce a deal now generally regarded as a huge mistake.

Richard Parsons, the former Chairman and CEO of Time Warner said recently, “It was beyond my abilities to figure out how to blend the old media and the new media cultures. They were like different species, and in fact, they were species that were inherently at war.” Seems like managing the soft stuff is always the hardest part of running a successful business.